Period of adjustment: CPAs are finding ways to put auditing and consulting on different sides of the conflict-of-interest dividing line.

EXECUTIVE SUMMARY

* THE NONAUDIT SERVICES Sarbanes-Oxley prohibits CPAs from providing to their public company audit clients are bookkeeping or services related to the accounting records or financial statements of the client; financial information systems design and implementation; appraisal or valuation services, fairness opinions or contribution-in-kind reports; actuarial services; internal audit outsourcing services; management functions or human resources; broker/dealer, investment adviser or investment banking services; and legal and expert services unrelated to the audit.

* REGIONAL FIRMS CAN CONTINUE TO CROSS-SELL nonaudit services--just not to the public companies they audit. Mid-size firms will have a better chance to sell their consulting services now that all firms are proscribed from offering specific nonaudit services to audited public clients, some say.

* SOME CPAs HAD BEEN EFFECTIVELY SHUT out from marketing nonaudit services to publicly traded companies because the larger national accounting firms charged significantly lower audit fees. Now that cross-selling is prohibited, small firms are in a position to credibly pitch nonaudit services.

* MANY FIRMS ARE PROVIDING CONSULTING services to clients on the consequences of Sarbanes-Oxley, adding more service specialties, increasing marketing budgets, dividing marketing between two staffs, adding marketing staff and hiring marketing directors to oversee their sales efforts.

* TO PURSUE AUDIT AND NONAUDIT MARKETING, a firm will need to analyze its client base, restructure the firm to effect the best provision of services and then market services according to each client's primary needs balanced against what's most profitable for the firm. CPAs should work out the decision together with their clients.

* BECAUSE AN INDIVIDUAL FIRM NO LONGER CAN serve as both the internal and outside auditor for a public company client, one CPA says it benefits his firm if a major competitor wins the work it loses. It effectively prevents that competitor from seeking a significant portion of work the firm wants and ensures that the internal auditor's work is top quality.

The auditor independence rules mandated by passage of the Sarbanes-Oxley Act in August 2002 are a double-edged sword for regional CPA firms. No longer able to use audit engagements as an opportunity to spot client needs and sell remedial consulting services such as internal controls tune-ups, information technology, actuarial research or human resources management, many multiservice, midsize firms must change their marketing plans. To avoid sacrificing the considerable investment they made to become versatile business services providers, most still will sell nonattest services--just not to the public company clients they audit. What these firms aren't doing is exiting one service market to focus on another--the strategy the largest firms have been forced to use. Here's how some midsize firms are adapting to the law's strict cleaving of audit and nonaudit services.

BRAVE NEW WORLD 

Sarbanes-Oxley is the most major overhaul of federal securities regulation since the Securities Exchange Act of 1934. By founding the Public Company Accounting Oversight Board, the legislation creates a system for federal oversight of public auditors. It also mandates new disclosure requirements for public companies and harsher civil penalties for individuals and firms convicted of accounting or reporting violations.

The act's prohibition against CPAs' performing any of eight nonaudit services for the public companies they audit is the biggest challenge to accounting firms. Those services are

* Bookkeeping or other services related to the accounting records or financial statements of the audit client.

* Financial information systems design and implementation consulting.

* Appraisal or valuation services, fairness opinions or contribution-in-kind reports.

* Actuarial services.

* Internal audit outsourcing services.

* Management functions or human resources consulting.

* Broker/dealer, investment adviser or investment banking services.

* Legal services and expert services unrelated to the audit.

Firms may provide other nonaudit services--including tax--if the public company's audit committee preapproves the service and the entity discloses the fact to investors in periodic reports.

Some practitioners expressed concern that the new accounting oversight board can--on a case-by-case basis if "appropriate to the public interest"--prohibit other services besides the eight stipulated. Others also worry that individual states may become overzealous and extend the federal prohibitions in ways that limit the work they can do for privately held companies, but those fears may be unwarranted (see "If It Ain't Broke ...," page 45).

Although a December 2002 SEC ruling (Final Rule: Revision of the Commission's Auditor Independence Requirements) indicated the new oversight committee would scrutinize all cross-selling activities very closely, its "prophylactic" approach clearly was not intended to be draconian. The rule states: "Accountants will continue to be able to provide a wide variety of nonaudit services to their audit clients. In addition, they of course will be able to provide any nonaudit service to noaudit clients." Regional firms still can cross-sell nonaudit services, such as IT systems, for example--just not-to the public companies they audit.

The rule also says, "While firms will be prevented from providing some consulting services to their audit clients, they will gain potential clients from other firms who are similarly situated."

SILVER LININGS 

Many firms that were stunned by both the scope and the swift enactment of the new federal securities legislation nevertheless think it will create opportunities. For one thing, the new climate of increased regulatory scrutiny means audits are likely to become more complex, require more work and generate higher fees, thereby increasing profits. Indeed, midsize firms will have a better chance to sell consulting services now that all firms are proscribed from offering specific nonaudit services to audited public clients, some say.

Those firms that think it will become easier to sell consulting services are stepping up to the plate with marketing and other changes such as

* Providing consulting services to clients about the consequences of Sarbanes-Oxley.

* Adding more service specialties.

* Increasing marketing budgets and adding marketing staff.

* Hiring a marketing director to oversee the firm's sales efforts and suggest new services.

Paul Sepp, CPA and director at Elmore & Associates, a Missoula, Montana, accounting firm, provides consulting services to clients on the ramifications of the new law. "Our clients wanted clarification of the law's specifics, and we wanted to set the stage for its potential impact on audit fees," he says. "We also advised them to begin implementing some of the corporate responsibility aspects of the legislation whether or not they are public companies."

Richard Kretz, CPA and managing partner at Kostin Ruffkess & Co., a Farmington, Connecticut, accounting firm, says he too has fielded calls from clients "wanting us to be a sounding board about the legislation. Some were disturbed we could no longer continue to perform certain work. Those often were uncomfortable discussions--for us and them." However, such calls present an excellent opportunity to cross-sell or, as Kretz puts it, "cross-service"--as long as it's not in a prohibited area. In some cases, he says, the firm will provide services the client needs without breaking them out or billing separately for them.

One useful step a firm can take to deal with the changes is to read the SEC's final version of the auditor independence requirements and note where conflicts might arise for its client base. The rules can be accessed at www.sec. gov/rules/final/33-7919.htm.

MARKETING GETS MORE STRATEGIC

Many multiservice, midsize firms say they'll talk to each client to learn which service--audit or consulting--matters most to it, then decide what to do based on the input. Several say they are restructuring internal operations and engaging with other CPAs in firm-to-firm cross-selling alliances. Other firms say the challenges wrought by the legislation have necessitated strengthening their sales units by upping the budget and adding a marketing specialist to the staff (see "Marketing Checklist," page 46).

Edward Mendlowitz, CPA, senior partner at Mendlowitz, Weitsen LLP, a three-partner, 12-person, East Brunswick, New Jersey accounting firm, says, "We hired a marketing director for the first time, increased our advertising budget by $35,000 this year and are doing a lot more direct marketing." The firm has "launched a number of new services for public companies--for example, corporate governance services to boards of directors and also a virtual bookkeeping service," he says. "Overall, we're putting more than $100,000 into developing these programs, which is a lot of money for a firm this size."

Mendlowitz says the firm's decision to offer corporate governance services is based on the observation that "boards of directors now feel greater pressure to perform their responsibilities to a higher standard. The firm teaches them how to read financial statements, understand what the reporting requirements are and what backup and additional information they should obtain from the company." The firm's marketing budget has been used for brochures, mailings to attorneys and personal contacts with clients who are directors.

To provide its virtual bookkeeping services, the firm set up a new department. It offers "accounting and bookkeeping services to companies that don't want to hire their own people. We do it in our office and they have access to it on the Internet," Mendlowitz says. "We have one ad alone costing us $25,000 a year and we're spending $40,000 overall on software and other advertisements," he says.

"We plan to go after large organizations that need to outsource their internal audit services--one of the prohibited services--and have started a new department to manage this," says Mendlowitz. "From a marketing standpoint, the legislation gives us an advantage we didn't have before: access to organizations that never would have talked to us because we weren't doing their audit."

Based on perceived advantages or disadvantages in the marketplace, other firms are adding items to or deleting them from their service menus. Scott Farb, CPA, a partner at the 60-person Beverly Hills, California, office of Rothstein, Kass and Co., says the impact of Sarbanes-Oxley has been mostly positive. The firm has hired 10 former senior executives from the Big Four in the past few months. "We've beefed up the business with people who are experts in areas that we want to market more fully, among them IT and tax consulting," Farb says.

The firm will promote the new specialties, Farb says, "through writing articles and making speeches, getting more involved in the community and intensified public relations-the old roll-up-your-sleeves approach."

SELLING AUDIT VS. NONAUDIT SERVICES

Reorganizing service niches within a firm is an ethical approach to selling under the new law. Ideas include separating a firm's marketing into two teams, one for audits and the other for nonaudit services, and plying different marketing channels for each, some CPAs say. To do this would require a firm to analyze the client base to determine the primary needs of each client, restructure the firm to effect the best provision of services and then market those services, balancing the client's needs against what's most profitable for the firm.

"What CPAs can do to prepare depends on whether you're looking at it from the audit or nonaudit side," says Farb. "What we're seeing because of Sarbanes-Oxley is a tremendous shortage of qualified audit professionals because a lot of them went into private industry or reevaluated their career options. Accountants must become more focused on auditing and the exposures related to it. I think continuing professional education is the key, as well as hands-on partner training and mentoring."

Many firms are in the analysis stage. They recognize significant procedural changes are necessary but are working out what those should be and how to implement them. "Newer channels to market our services will involve extra effort, cost and changes in our business-unit makeup," says Mark Hildebrand, CEO of Crowe Chizek & Co. LLP, the large Indianapolis-based, multi-service accounting firm. "We're still trying to flesh out what those will be."

Other firms will split their structures in two, says Robert Bunting, CPA and chairman of the large Seattle-based accounting firm Moss Adams LLP. His firm has developed two marketing strategies to attract clients post-Sarbanes: plan A and plan B. "Since we're primarily an audit and tax firm, our plan A is to market these services in our proposal to a potential client," he says. "But if it appears that the engagement will go to another firm, we will immediately shift into plan B--opportunities for specialized work. Each of these areas, or plans, will have a separate marketing team, philosophy and strategy." In some cases it will mean giving up internal or external auditing as well as consulting.

In auditing, because "firms no longer can serve as both the internal and outside auditors for their public company clients, the firm or the client now must decide which of those functions to assign to another firm," he says. "In cases where my firm can influence this decision, it benefits us if our most effective competitor wins the work we're losing."

The reasoning is this: "Under Sarbanes-Oxley that firm would be prevented from seeking most of the other work we want. In addition, as outside auditors, we may have to rely extensively on the work of internal auditors, so we want them to be among the best. This is self-serving, but it's not entirely a financial issue. If our best competitors do this high-caliber internal audit work, we and the client both are likely to benefit," Bunting says. "We hope our competition will take a similar view and reciprocate in areas where they face conflicts." Recognizing that the marketplace will be divvied up in new patterns, some firms will pitch their services to competitors' clients too (see "Respect the Spirit As Well As the Letter of the Law," above). Ser vices such as tax compliance might still be up for grabs, "but many larger clients have been splitting those off for some time anyway," Bunting says.

Overall, the legislation has created a new playing field, providing opportunities for some firms and obstacles for others. "We've backed away from our traditional strategy of being all things to all people," says Kretz. "We're unbundling from a marketing standpoint--selling auditing, accounting and tax services as separate areas of expertise. It's time to get back to basics now."

REAPING AN UNEXPECTED HARVEST

For the most part, CPAs envision some good arising from the new federal securities legislation.

However, "there will be some initial, short-term shock--in our case it means that our go-to-market strategy and channels of distribution for prohibited services must change," says Hildebrand. "Obviously, in situations where we do an external audit for an SEC client and are restricted from certain other services, we simply will market that capability elsewhere."

Farb also reads the same tea leaves. "Frankly, the legislation has created a once-in-a-lifetime chance for us to obtain intellectual capital from the big firms--people who are reexamining their career paths," says Farb, who heads a real estate niche. "We see the act as creating an opportunity for us in the middle market, too, now that big firms are less likely to focus on it. We're marketing from an industry perspective--emphasizing our boutique services," Farb says. "For example, we're getting closer to professional organizations such as the National Association of Industrial and Office Properties and the Urban Land Institute, sponsoring events and speaking at conventions. We're encouraged by the fact that we've acquired 15 new privately held clients in the past few months," he says.

Mendlowitz says his firm will realize more audits and higher fees because of the legislation. "We were shut out of marketing nonaudit services to publicly traded companies because the national accounting firms would lowball the audit with the goal of selling their pricier nonaudit services. Now that cross-selling is prohibited, the playing field has leveled."

Kretz also perceives more opportunities to market audit services. "We're a regional firm and, like other firms this size, traditionally make most of our money doing audits," he says. "But when we bid $50,000 on an audit and a national firm bid $30,000--using the audit as a loss leader--we had a pretty hard sell. Now that everybody is back to trying to make money on the audit, it's a much fairer game."

It's also one that may have fewer participants in the future. "I expect the national firms will begin peeling off some of their smaller SEC clients and internal audit work to focus on higher margin business, which in the long run will be an opportunity for us," Kretz says. "We're building stronger relationships with national firms. Recently we met with the managing director of one to discuss our availability for local referrals in situations where it no longer could provide services to a client. As a regional firm we're not necessarily in competition with them, whereas they'd be reluctant to refer work to another national firm because they don't want them getting a foot in the door."

TALK TO YOUR CLIENTS

As accounting firms and their clients shake up their relationships, new ones will emerge. "Clients will move away from monolithic relationships," one source says. "They'll shop for the best in class in each service category, no longer defaulting to their auditing firms for the services. Consequently, clients are likely to have multiple accounting firm relationships."

Bunting says his firm now faces difficulty in determining which services it will continue to provide existing clients--audit work or nonaudit specialty services. "Sometimes we have to ask ourselves whether we want the audit," he says. "That's a very tough question to answer, so we have been asking our clients to participate in this decision making. We just had an audit client tell us we were number one for the audit, but the company was giving it to another firm because our nonaudit services to it were too important. We discussed this and reached a decision together."

Rather than become a "victim" of the changes wrought by Sarbanes-Oxley, Bunting says, the firm will continue to be proactive--"choosing what we want to on a client-by-client basis, based on our analyses and theirs. In the long run, the more discussions--even difficult ones--you have with clients the stronger the relationship."

One final word of caution: Firms must pay very close attention to regulatory pronouncements, which are ongoing. This is a good time to use the AICPA's services to keep track of any potential movement by state societies, the SEC, FASB and Congress toward additional restrictions (go to www.aicpa.org/sarbanes/index.asp or call the Sarbanes-Oxley hot line at 866-265-1977).

Consulting Had the Edge

The predicted profit for each dollar of traditional services was 26.8 cents and for consulting services was 28.7 cents.

Source: The Practicing CPA, August 2001. From "The Impact of Consulting Services on Small Firms" by Nicholas J. Mastracchio and Jeffrey Lippitt.

If It Ain't Broke ...

Under Sarbanes-Oxley, accounting firms that audit privately held, not-for-profit, government, family-owned or closely held organizations may still market nonaudit services to these clients. But there is growing concern that some states and other regulatory agencies will extend the federal law to encompass non-public-company audits. The tremors caused by the new legislation will seem minor compared to the aftershocks that will occur if states move to extend the federal law to nonpublic-company clients, several firms say.

"It will be a disaster, says Richard Kretz, CPA, of Kostin Ruffkess & Co., Farmington, Connecticut. "It's the private companies in particular that depend on us for Consulting, and if we suddenly could no longer help them, it's a big problem for them--and for us. A big part of our income is the nonpublic market."

The recent GAO amendment (number 3) to its government auditing standards (yellow book), limiting the scope of services CPAs can provide to government agencies, contains prohibitions similar to those of Sarbanes-Oxley. "For us, the federal law has had limited impact because owner-managed and privately held company audits are the `sweet spot' of our practice," says Robert Bunting, CPA, of Moss Adams LLP, Seattle.

"But if there is a cascade effect and the states decide to regulate audits in the private sector, we will be profoundly affected," says Mark Hildebrand, Crowe Chizek & Co. LLP, Indianapolis. "Sarbanes-Oxley didn't give me great cause for concern because most of our clients are closely held or private and not subject to the act," he says. "But we keep hearing from those clients that the states are preparing to clamp down and not allow firms like ours to offer a full complement of audit and nonaudit services. If the states restrict practice in this way, it will have a significant impact on our firm and a damaging effect on midsize companies and the economy."

Marketing Checklist

Here are cross-selling ideas CPA firms can draw on in the new marketing environment:

* Use the confusion about the implications of Sarbanes-Oxley to open discussions with existing clients and help them understand how the firm can continue to serve it. These conferences may be a new consulting service depending on how detailed and time-consuming they are. They also help the firm realize what services clients want and the expertise it now must wield.

* Change the marketing structure and budget to parallel the firm's reorganized service segments. If the firm expects to deemphasize audits to 40% of the practice, then only 40% of resources, both financial and staff, should be directed to this business segment.

* To meet needs your competitors can't under the new law, add or strengthen the requisite services. Sources say many CPAs will focus only on audits, leaving a pool of clients for other services. Hire experts in the new service segments. (Many firms will be downsizing people well versed in the expertise your firm intends to acquire.)

* Refer your clients for services to those firms you consider your chief competititors and make sure they mention you sent them.

* Add a marketing director to the staff, someone well versed in sensing and seizing opportunities in a changing marketplace. Many industries have undergone profound change in recent years--energy, financial services and transportation are examples. Outside perspective may be what your firm needs, even if the specialist is hired on a consulting basis. Investing in marketing, even temporarily, will help the firm acquire skills that yield the capacity to handle additional clients down the road.

Respect the Spirit As Well As the Letter of the Law

Firms that refer business to competitors with the understanding that the courtesy will be reciprocated are within the law, but they still must be circumspect. While referrals in the accounting profession are nothing new and referral networks are part and parcel of many professional associations, Robert Bunting, CPA, of Moss Adams, Seattle, warns that firms must avoid a formal fee-sharing arrangement or the appearance of a quid pro quo.

"There is nothing that precludes you from referring business to another firm or having that firm refer business to you," he says. "But the important thing is to maintain independence."

Art Siegel, retired vice chairman of the former Price Waterhouse (now PricewaterhouseCoopers), advises similar caution. "Firms should be careful to not give the impression they are trying to get around the law through these strategic marketing alliances," says Siegel, who in his long career also headed the now-defunct Independence Standards Board. "I would make sure everyone understands what is going on, particularly the audit committee of the client. Anything that potentially compromises auditor independence should be carefully evaluated."

RUSS BANHAM is a Seattle-based author, journalist and playwright. His new book, The Ford Century, a history of Ford Motor Co., came out in November 2002.